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Financial and Managerial Accounting: The Basis for Business Decisions, 12/e

Cost-Volume-Profit Analysis

Chapter Summary

 Chapter 19 - SummaryLO1Explain how fixed, variable, and semivariable costs respond to changes in the volume of business activity.Fixed costs (fixed expenses) remain unchanged despite changes in sales volume, while variable costs (or expenses) change in direct proportion to changes in sales volume. With a semivariable cost, part of the cost is fixed and part is variable. Semivariable costs change in response to a change in the level of activity, but they change by less than a proportionate amount.LO 2Explain how economies of scale can reduce unit costs.Economies of scale are reductions in unit cost that can be achieved through a higher volume of activity. One economy of scale is fixed costs that are spread over a larger number of units, thus reducing unit cost.LO 3Prepare a cost-volume-profit graph.The vertical axis on a break-even graph is dollars of revenue or costs, and the horizontal axis is unit sales. Lines are plotted on the graph showing revenue and total costs at different sales volumes. The vertical distance between these lines represents the amount of operating income (or loss). The lines intersect at the break-even point.LO 4Compute contribution margin and explain its usefulness.Contribution margin is the excess of revenue over variable costs. Thus it represents the amount of revenue available to cover fixed costs and to provide an operating profit. Contribution margin is useful in estimating the sales volume needed to achieve earnings targets, or the income likely to result from a given sales volume.LO 5Determine the sales volume required to earn a desired level of operating income.The sales volume (in units) required to earn a target profit is equal to the sum of the fixed costs plus the target profit, divided by the unit contribution margin. To determine the sales volume in dollars, the sum of the fixed costs plus the target profit is divided by the contribution margin ratio.LO 6Use the contribution margin ratio to estimate the change in operating income caused by a change in sales volume.Multiplying the expected dollar change in sales volume by the contribution margin ratio indicates the expected change in operating income.LO 7Use CVP relationships to evaluate a new marketing strategy.An understanding of CVP relationships assists managers in estimating the changes in revenue and in costs which are likely to accompany a change in sales volume. Thus they are able to estimate the likely effects of marketing strategies on overall profitability. An understanding of cost behavior--the manner in which costs normally respond to changes in the level of activity--is required in each remaining chapter of this textbook. In these chapters, we will explore the use of accounting information in evaluating the performance of managers and departments, in planning future business operations, and in making numerous types of management decisions. The concepts and terminology introduced in Chapter 19 will be used extensively in these discussions.